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5 A REVOLUTION IN FINANCIAL MANAGEMENT - THE PUBLIC FINANCE ACT 1989

Last updated: 1 March 1998

The old system - Cash Accounting

Until 1989 the New Zealand Government financial management system operated on a cash basis. Little or no consideration was given to multi-year items such as depreciation or accrued expenses, and each financial year stood on its own, disconnected from the financial activities (including capital investment) of previous years or of any following years.

Departmental Budgets were constructed on the basis of inputs - the costs of production, rather than on outputs - the quality and value of departmental products. This central control of inputs substantially limited the capacity of Public Service managers to actually manage - to command their resources. If the budget for an item ran out two-thirds the way through the year - even for perfectly good reasons - it would be extremely difficult to obtain authority to transfer funds from another underspent item to provide an additional resource. Clearly, no business operating in the commercial world could afford to restrict its flexibility in such ways.

The cash accounting system in fact allowed departments to operate in an environment that bore little relationship to the realities of business operations. The incentives became somewhat perverse - to acquire as large a budget as possible, and to make sure it was spent by the end of the year. The reward would generally be the same budget the next year. Underspending would risk a reduced budget.

From the Government's point of view adjustments for the purposes of fiscal management could readily be made through manipulation of inputs - reducing overall staff numbers for example, or increasing funds available for building construction to boost economic activity.

The system had numerous shortcomings, not the least being that concepts of performance and accountability were sketchy. What was 'good performance' - spending all of the departmental allocation? Was that what managers were ultimately accountable for?

The new legislation

The new system introduced through the Public Finance Act is based on three important principles:

Parliamentary scrutiny - The Government receives its authority to spend from Parliament, which must be satisfied with the justification advanced for money to be appropriated, and that money is spent responsibly, for the purposes for which it is provided.

Accountability - Departments have to report to Ministers, and Ministers to Parliament, to show that they have acted within their authorities.

Improved managerial performance - Departments and other Government agencies need incentives to encourage good financial management practices, and prudent but enterprising use of resources.

The long title of the Public Finance Act describes the spirit and intent of the legislation:

"An Act to amend the law governing the use of public financial resources and to that end to-

(a) Provide a framework for Parliamentary scrutiny of the Government's management of the Crown's assets and liabilities, including expenditure proposals; and

(b) Establish lines of responsibility for the use of public financial resources; and

(c) Establish financial management incentives to encourage effective and efficient use of financial resources in departments and Crown entities; and

(d) Specify the minimum financial reporting obligations of the Crown, departments and Crown entities; and

(e) Safeguard public assets by providing statutory authority and control for the raising of loans, issuing of securities, giving of guarantees, operation of bank accounts, and investment of funds."

Key features of the reformed system

The new system has introduced the concepts of Ministers as purchasers, and departments and other agencies as suppliers. Ministers purchase outputs in order to achieve the Government's desired outcomes. As an example, Ministers will purchase a range of policy adviceoutputs from the Ministry of Transport and other departments, and a range of regulatory outputs from Transit New Zealand and other agencies, in order to achieve the Government's desired outcomes relating to a safe and efficient land transport system. Each purchaser and supplier will know what the desired outcome is, exactly what they are contracting to purchase or supply and, as all of the arrangements are transparent, how their roles and responsibilities relate to those of the other parties. The suppliers will also know that at the end of the term of the contract their performance will be rigorously assessed, and the information obtained from this will be used in developing the next sequence of contracts. The positive incentives in these arrangements are powerful - they resemble, in effect, the arrangements and incentives of the commercial marketplace.

Outputs have become the basis of appropriation by Parliament and reporting back to Parliament.

Purchase Agreements

The goods and services to be supplied by a department to a Minister are set out in a purchase agreement. These agreements specify the quality, quantity, price and timeliness of each output to be supplied. The arrangement allows a Minister to make considered and deliberate decisions as to what he or she wishes to purchase each year, and, where there is scope for competition, to select the best supplier. Questions of quality and price will clearly be very important in these considerations. The sorts of information included in purchase agreements is shown below.

Items in Purchase Agreement

term of agreement

description of outputs

cost of outputs

performance measures and standards

procedures for assessing performance

reporting requirements

rewards and sanctions

procedures for amendment of the agreement

procedures for resolving disputes

As part of the support services it provides for its Minister a department may administer purchase agreements with other non-departmental suppliers.

The new accounting

Departments now report the full cost of their activities in producing outputs and conducting their business. This includes depreciation on assets owned, and investments required to ensure they can operate effectively over the longer term. Managers now have much more freedom to command the resources under their control - they can buy and sell assets, property and equipment, recruit and develop the staff they need, and move money about within outputs. They work out their own cash requirements, and run their own bank accounts.

Summary

The new financial management system has had three very significant benefits:

It has complemented and consolidated the changes made by the State Sector Act, which made Public Service managers directly responsible to their Ministers for the conduct of their departments

It has substantially increased the volume and quality of relevant information available about departmental operations, particularly about the true costs of producing and supplying individual outputs, and about the overall financial worth of the State sector

It has substantially enhanced accountability, with the roles and responsibilities of Ministers and chief executives clearly defined, particularly in relation to the purchase and supply of outputs.

The reforms have shifted the focus of financial management away from detailed control of costs of production, and much more squarely onto the value of the goods and services supplied - and hence, achievement of the Government's desired outcomes.